Chapter D: Taxing consumption

D2. The goods and services tax

D2–1 The current GST can be complex and costly

The breadth of Australia's GST base is around the OECD average

The goods and services tax (GST), adopted in 2000, is a type of value added tax (VAT). A VAT taxes a business's sales, but refunds tax paid on their purchases. Consumers, who do not receive a refund, therefore bear the burden of the tax. In this way, the VAT is a type of consumption tax.

The Asprey Committee (1975) proposed a VAT to replace the wholesale sales tax and extend the consumption tax base to services. This followed European practice from the 1960s and 1970s, where VATs replaced inefficient taxes on business turnover and narrow sales taxes (Ebrill et al. 2001, p. 6). Except in the case of New Zealand's GST, VATs around the world do not tax the consumption base on a comprehensive basis (see Chart D2–1).

Chart D2–1: VAT revenue ratio, 2005(a)

Unweighted average used for OECD. The VAT revenue ratio = (VAT or GST revenue)/([consumption (including government consumption) — VAT or GST revenue] x standard VAT or GST rate). An 'ideal' value added tax, which would apply at a single rate on all domestic consumption, would have a VAT revenue ratio of 1. A VAT revenue ratio above 1 can reflect investment in residential housing that is taxed on a prepaid basis (and rents are input taxed) but is not included in national accounts as consumption, or cascading effects of input taxation in the value chain.

Source: OECD (2008a).

New Zealand's GST has approached full coverage of the consumption tax base. New Zealand does this by taxing almost all goods and services, including public services. There are very few exemptions, and only for technical reasons. Australia's GST base is close to the OECD average, raising revenue from little more than half of the consumption base (see Chart D2–1).

A narrower GST does not mean it is fairer, but adds complexity

Income redistribution to make Australia fairer is primarily the job of the personal income tax and transfer system (see Section A1 Personal income tax). This means that other taxes and charges can be used in the most efficient way, reducing the overall complexity of the system. It is very difficult to target GST exemptions on some products to certain groups.

For example, while the proportion of income spent on GST-free food does fall with income, absolute actual expenditure on GST-free food is almost six times greater for the highest than the lowest income groups. Among food categories, expenditure only on powdered milk, canned meat and offal actually falls with income (ABS 2005). As a result, more than one-third of the $5 billion exemption for GST-free food (Australian Government 2009, p. 205) benefits households in the highest 20 per cent of the income distribution. These sorts of exemptions add significantly to the complexity of the GST.

The invoice-credit method has compliance benefits but costs as well

An individual sale or purchase of a commodity can be 'taxable' (that is, tax is payable on the sale of taxable goods, and tax paid previously in the supply chain is refunded), 'GST-free' (that is, tax is not payable on the sale of GST-free goods, and tax paid previously in the supply chain is refunded) or 'input taxed' (that is, no tax is payable on the supply of input-taxed goods, but the tax previously paid in the supply chain is not refunded).

The need to determine the tax status of each sale or purchase requires the use of tax invoices to provide evidence of liability to GST or eligibility for a refund. The 'invoice-credit method' (illustrated in Chart D2–2) attributes a tax liability (for sales), or an input tax credit (for purchases) to individual transactions, for which a 'tax invoice' must be generated. The net amount is remitted to the Australian Tax Office (ATO).

Chart D2–2: Invoice-credit method consumption tax

Tax liability = tax rate (output) minus tax rate (input)

There is an argument that tax invoices make the GST 'self-enforcing', as a business purchaser of a taxed good or service requires a valid tax invoice from their supplier in order to receive an input tax credit. While this imposes an additional compliance burden for taxpayers, it creates an additional audit trail for the ATO.

However, the inherent compliance benefits of an invoice-credit method should not be overstated. While business consumers have an incentive to ask for a tax invoice, consumers have no need for a tax invoice, as they cannot claim a tax credit. As such, tax collected at the final retail stage is not self-enforcing. Moreover, the existence of a tax invoice may assist but does not in itself ensure compliance. A false tax invoice might be used to make a claim for a credit. A missing or absent tax invoice may be used to understate sales.

In addition, the widespread use of tax invoices as a basis of systematic cross-checking between tax paid and tax claimed, while simple in concept, is costly in practice (see Box D2-1). The ATO's compliance program is built largely on voluntary compliance, with targeted audit activity in response to emerging risks, rather than auditing millions of routine transactions.

Box D2–1: Cross-checking invoices in practice — South Korea

South Korea introduced its invoice-credit VAT in 1977. To ensure compliance, taxpayers were required to send copies of each tax invoice to the tax authority's central computer centre for cross-checking.

These cross-checking programs reduced the number of cases where matching sales and purchase invoices could not be found, although many of the remaining cases resulted from transcription errors rather than fraud. However, the cross-checking program was cancelled after the resources costs for administrator, and the compliance costs for taxpayers, were found to outweigh the benefits.

Adapted from Ebrill et al. 2001, p. 150.

GST compliance can be costly …

The costs incurred by business in complying with the GST arise from registration requirements, issuing tax invoices, distinguishing between different types of supplies, reporting and remitting GST to the ATO, computing and software requirements, record keeping and auditing, understanding the GST law, and impacts on cash flow.

The Board of Taxation (2007, p. 112) has highlighted GST-specific compliance issues in the course of its review of small business tax compliance costs. It found that working out exemptions and concessions is a confusing and time-consuming task. Small businesses also find it difficult to classify supplies into taxable, GST-free and input-taxed items for tax purposes, and into capital and non-capital items for the business activity statement (BAS).

The requirement to receive and retain all tax invoices for five years is also costly. In addition, the not-for-profit sector, comprising around 700,000 organisations, can incur significant compliance costs associated with the GST. While the sector receives GST concessions, compliance with the regime is reportedly difficult, at least partly because of the regular use of untrained volunteers for administration.

There has been no comprehensive quantitative study of GST compliance costs in Australia. A study of compliance costs in the UK suggests that VAT compliance costs decrease as a proportion of sales as sales increase, with compliance costs ranging from 0.003 per cent of taxable sales for large businesses to almost 2 per cent for small businesses (Sandford et al. 1989, p. 116). Estimates of compliance costs under a VAT system as reported by the United States Government Accountability Office (2008, p. 16) suggest that small business with sales under $50,000 face a cost of compliance of 2 per cent of annual sales, compared with 0.04 per cent for businesses with sales over $1 million.2

Compliance costs increase when different supplies are given different tax treatments. While most supplies are taxable, some supplies are GST-free, or input-taxed.

… especially for small business

In 2007–08, approximately 2.6 million entities were registered for GST, of which nearly two million lodged a BAS. More than half a million taxpayers were in a net refund position. Of those taxpayers that had a net GST liability, less than one thousand were responsible for 40 per cent of ATO GST liabilities. Almost one million taxpayers had a positive GST liability of less than $10,000 (see Chart D2–3). This suggests that a large number of very small businesses bear the compliance costs of the GST while contributing very little to overall revenue collection.

Chart D2–3: Net GST liabilities by amount, 2007–08

Source: ATO 2009.

While businesses with an annual turnover below $75,000 and non-profit organisations with a turnover below $150,000 are not required to register, many are still voluntarily registered. In 2007–08 around half GST registrations were voluntary. This could be due to pressure from their business customers to register so they correspond with their customers' accounting systems and allow their customers to claim input tax credits.

Moreover, once a business has registered for the GST, there is often little incentive to deregister. Deregistration can be complicated, requiring a range of adjustments in relation to previously claimed input tax credits.

The take-up of a range of optional small business concessions has been very low. For example, in 2007 only 2 per cent of eligible small business (roughly 2,400 out of 110,000) used a simplified accounting method to calculate GST (Board of Taxation 2008, p. 50). This suggests that the perceived benefits of some concessions are not great.

Findings

Complying with the GST is costly for many businesses — particularly small businesses. Much of this complexity is structural, and flows from differential tax treatment of different goods and services. The smallest businesses can be under pressure to be in the GST system.

2 These figures are based on studies of New Zealand, Canada and the United Kingdom.